How savings interest is calculated, paid and taxed

Every savings rate in Australia is advertised as an annual figure, written p.a. for per annum. Almost none of them are paid annually. The bank calculates interest on the closing balance of your account each day, then adds up those daily amounts and pays the total once a month, usually on the last business day or the first of the following month.

The daily calculation is simple arithmetic: the closing balance, multiplied by the annual rate and divided by 365, is what one day earns. A month with 31 days earns more than a month with 28, which is the most common reason two consecutive interest payments differ even though nothing about your balance or rate changed.

Because the calculation runs on the closing balance, timing matters more than people expect. Money deposited in the morning and withdrawn that afternoon earns nothing. Money left in the account overnight on the last day of the month earns a full day. It is a small effect on a small balance and a real one on a large deposit.

When the monthly interest is paid into the same account, next month’s calculation runs on a slightly larger balance. That is compounding, and over a long horizon it is the difference between a savings balance that grows in a straight line and one that curves upward.

The effect is modest in the first year and meaningful over five. It is also the reason a rate advertised as paid monthly is worth marginally more than the same rate paid annually, since the money starts working sooner.

Two habits cancel compounding out. The first is sweeping the interest into a transaction account each month, which converts it back to simple interest. The second is a withdrawal condition: on accounts where the bonus requires no withdrawals, taking the interest out can itself break the condition and cost you far more than the interest was worth.

Interest is assessable income in Australia. It is added to your other income and taxed at your marginal rate, so what you keep depends entirely on which bracket you are in, not on anything about the account. There is no separate savings tax and no tax-free allowance that applies to interest specifically.

Banks report interest they pay directly to the ATO, and it generally appears pre-filled in your return. The figure is reported for the financial year in which the interest was paid rather than when it accrued.

The parts that catch people out:

• No TFN, no exemption. If you do not quote a tax file number, the bank must withhold tax at the top marginal rate plus the Medicare levy, currently 47%. It is refundable when you lodge, and quoting a TFN to the bank stops it.
• Joint accounts are split by ownership. Interest on a joint account is generally split equally between the holders unless the money is owned in different shares, and reported that way. For a couple in different tax brackets that matters.
• Children’s accounts follow who controls the money, not whose name is on the passbook. Where a parent operates the account and uses the funds, the interest is generally treated as the parent’s.
• Interest is taxed in the year it is paid. A term deposit that matures in July pushes its whole interest payment into the new financial year, which can affect which year the income lands in.

Deposits with an Australian authorised deposit-taking institution are protected by the Financial Claims Scheme, the government guarantee that applies if the institution fails. The cap is $250,000 per account holder per institution, and it covers savings accounts, transaction accounts and term deposits alike.

The wording that matters is per institution, which in practice means per banking licence. A single licensed bank can operate several consumer brands, and deposits across those brands share one $250,000 cap rather than getting a fresh one each. Spreading money across brands only adds cover where the brands sit under different licences. APRA publishes the list of licensed institutions and the brands that trade under them.

For a joint account, each holder's equal share is added to their other deposits at that institution, so two holders with nothing else there are covered for up to $500,000.

It takes about two minutes:

1. The interest credit appears on the statement or in the transaction list. It is normally the last entry of the month or the first of the next.
2. The expected amount is the balance multiplied by the rate, divided by 365, multiplied by the number of days in the month. A difference of a dollar or two is normal, since the balance moved during the month.
3. A large shortfall usually means a different rate applied. Introductory rates expire, bonus conditions get missed, and rate changes are notified by email or in-app message rather than announced.
4. The rate against what is currently offered, including by the same bank on a different account. Providers rarely move existing customers onto their newer products automatically.

The last point is where the money is. Savings rates move with the cash rate in both directions, but they do not move uniformly across products, and an account that was competitive two years ago frequently is not today. Switching a savings account is also far easier than switching a loan.